nonprofit starts a for-profit -- a tax question


N

NPOguy

Our tax exempt 501(c)3 nonprofit corporation was to start a for-profit
enterprise. Our plan is to form a separate for-profit corporation or LLC
where the nonprofit owns all of the shares of the for-profit corporation or
is the sole member of the for-profit single-member LLC.

My question is about the federal income tax for the for-profit corporation
or LLC. The question is, if the for-profit corporation or LLC earns a
profit (of say, $30,000 for example) and then, just before the close of the
year, makes a $30,000 donation to our tax exempt 501(c)3 nonprofit
corporation, does the for-profit entity then owe no federal income taxes for
that year?

Or, to put it another way, if a for-profit entity donates all of its net
profit for the year to a tax exempt 501(c)3 nonprofit corporation before the
close of the year, does that reduce the for-profit's federal income tax
burden to zero?

If I didn't explain the question correctly, or you need more information,
let me know and I will respond back.

Thanks.
 
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S

Stuart A. Bronstein

NPOguy said:
Our tax exempt 501(c)3 nonprofit corporation was to start a
for-profit enterprise. Our plan is to form a separate
for-profit corporation or LLC where the nonprofit owns all of
the shares of the for-profit corporation or is the sole member
of the for-profit single-member LLC.

My question is about the federal income tax for the for-profit
corporation or LLC. The question is, if the for-profit
corporation or LLC earns a profit (of say, $30,000 for example)
and then, just before the close of the year, makes a $30,000
donation to our tax exempt 501(c)3 nonprofit corporation, does
the for-profit entity then owe no federal income taxes for that
year?
I haven't researched this, but my first reaction is that it would be
considered a dividend rather than a tax exempt contribution. A
nonprofit that runs a for-profit business that is unrelated to its
tax exempt purpose, it is required to pay taxes on the unrelated
business income. Trying to get around that by presenting it as a
deductible donation rather than taxable income would, it seems to me,
be challenged by the IRS.

___
Stu
http://DownToEarthLawyer.com
 
I

ira smilovitz

I haven't researched this, but my first reaction is that it would be
considered a dividend rather than a tax exempt contribution. A
nonprofit that runs a for-profit business that is unrelated to its
tax exempt purpose, it is required to pay taxes on the unrelated
business income. Trying to get around that by presenting it as a
deductible donation rather than taxable income would, it seems to me,
be challenged by the IRS.

___
Stu
http://DownToEarthLawyer.com
I would agree. It would only be a contribution if the net profit were donated to an unrelated 501(c)3.

Ira Smilovitz
Leonia, NJ
 
G

Gene E. Utterback, EA, ABA

"ira smilovitz" wrote in message

I haven't researched this, but my first reaction is that it would be
considered a dividend rather than a tax exempt contribution. A
nonprofit that runs a for-profit business that is unrelated to its
tax exempt purpose, it is required to pay taxes on the unrelated
business income. Trying to get around that by presenting it as a
deductible donation rather than taxable income would, it seems to me,
be challenged by the IRS.

___
Stu
http://DownToEarthLawyer.com
I would agree. It would only be a contribution if the net profit were
donated to an unrelated 501(c)3.

Ira Smilovitz
Leonia, NJ



I agree as well AND WOULD ADD that making such a donation might put the tax
exempt status in danger due to the related party rules. This is the same
thing that keeps me from forming a tax exempt entity, contributing all my
income to it, then having it "reimburse" me for my expenses as an officer or
director of the tax exempt entity.

It just won't work,
Gene E. Utterback, EA, RFC, ABA
 
S

Stuart A. Bronstein

I agree as well AND WOULD ADD that making such a donation might
put the tax exempt status in danger due to the related party
rules. This is the same thing that keeps me from forming a tax
exempt entity, contributing all my income to it, then having it
"reimburse" me for my expenses as an officer or director of the
tax exempt entity.
I think that might work if you set up a religious organization and
you were ordained and its clergyperson.

You could probably justify that because, don't your clients, when
they see tax returns you prepare, generally shout, "Oh my God!!!" ?
___
Stu
http://DownToEarthLawyer.com
 
R

removeps-groups

I would agree. It would only be a contribution if the net profit were donated to an unrelated 501(c)3.
i agree, but in addition, I think corporations can only deduct 10% of
their AGI. Corporations with S election can donate 20% to 50% of
AGI. Unused deductions are carried forward.
 
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P

paulthomascpa

Corporations with S election can donate 20% to 50% of AGI.

Huh? Charitable contributions made by an S Corp are passed through to the
shareholders and deducted on each shareholders 1040. The "S" can donate all
they want. Limits on deductions would apply for each shareholder.
 
N

NPOguy

Stuart A. Bronstein said:
I haven't researched this, but my first reaction is that it would be
considered a dividend rather than a tax exempt contribution. A
nonprofit that runs a for-profit business that is unrelated to its
tax exempt purpose, it is required to pay taxes on the unrelated
business income. Trying to get around that by presenting it as a
deductible donation rather than taxable income would, it seems to me,
be challenged by the IRS.
Duh..., why didn't I think of that? What you and others wrote about this
makes complete sense since the so-called "donation" would be to the owner of
the for-profit corporation.

What I was mostly trying to think about was how to not have the for-profit
have to pay taxes on its income. But, as someone suggested, I guess that
could be achieved simply by setting up the for-profit as an S-corp with the
nonprofit owning the shares.

For the nonprofit, I guess it would end up being unrelated business
income -- which, of course, would be taxable to the nonprofit. I am not
sure if the tax consequences would be different for the nonprofit if it
received all of the income from its subsidiary in the form of dividends, but
my guess is that the end result would be about the same.

We (the nonprofit) do have an email in to a local CPA to set up a
consultation visit about this. We want to figure out with him what the best
way to set this up would be -- an LLC, an S-corp, a C-corp, etc. But, while
waiting to hear back about an appointment time, I thought I would float this
idea here to get some initial feedback and ideas.

Thanks for all of the replies so far. They were really helpful.
 
N

NPOguy

NPOguy said:
. . . . We (the nonprofit) do have an email in to a local CPA to set up a
consultation visit about this. We want to figure out with him what
the best way to set this up would be -- an LLC, an S-corp, a C-corp,
etc. But, while waiting to hear back about an appointment time, I
thought I would float this idea here to get some initial feedback and
ideas.
P.S. I know this is a long shot but, since we are located in Southern New
Jersey, does anyone know of a CPA or accounting firm that is located in our
area that would have particular experience and expertise in the area of tax
exempt organizations and multiple entity structures?

I know that some larger tax exempt organizations create multiple entity
structures, including for profit and nonprofit entities such as management
companies and subsidiaries etc. I also know that it is a complex area of
law and taxation, so we would like to find an accounting firm near us with
particular experience and expertise in that area. We have not heard back
yet from the one CPA firm that we contacted, but we also do not yet know if
they have any particular expertise or knowledge in this somewhat unique
aspect on nonprofit law and taxation.
 
P

paulthomascpa

NPOguy said:
We (the nonprofit) do have an email in to a local CPA to set up a
consultation visit about this. We want to figure out with him what the
best way to set this up would be -- an LLC, an S-corp, a C-corp, etc.
But, while waiting to hear back about an appointment time, I thought I
would float this idea here to get some initial feedback and ideas.



For ease of operation, just have a for-profit branch/division of the
not-for-profit entity. Much like a church run daycare might be taxed on
their profits (if any). If that's not doable, then maybe consider setting
up a for-profit company owned by one or more of the Officers or Directors of
the not-for-profit. More complex I think, as most NPO's have some turnover
in their Board from year to year.
 
R

removeps-groups

Huh?  Charitable contributions made by an S Corp are passed through to the
shareholders and deducted on each shareholders 1040.  The "S" can donate all
they want.  Limits on deductions would apply for each shareholder.
Yeah, I meant that S corps can donate all they want, but the ultimate
person who pays tax, namely the shareholder, is subject to limits.
 
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R

removeps-groups

What I was mostly trying to think about was how to not have the for-profit
have to pay taxes on its income.  But, as someone suggested, I guess that
could be achieved simply by setting up the for-profit as an S-corp with the
nonprofit owning the shares.

For the nonprofit, I guess it would end up being unrelated business
income -- which, of course, would be taxable to the nonprofit.  I am not
sure if the tax consequences would be different for the nonprofit if it
received all of the income from its subsidiary in the form of dividends, but
my guess is that the end result would be about the same.

We (the nonprofit) do have an email in to a local CPA to set up a
consultation visit about this.  We want to figure out with him what the best
way to set this up would be -- an LLC, an S-corp, a C-corp, etc.  But, while
waiting to hear back about an appointment time, I thought I would float this
idea here to get some initial feedback and ideas.

Thanks for all of the replies so far.  They were really helpful.
What are the UBTI tax rates? From http://www.irs.gov/charities/article/0,,id=158822,00.html
it looks like they are the same as corporate tax rates. And these
seem to be:

Taxable income over Not over Tax rate

$ 0 $ 50,000 15%
50,000 75,000 25%
75,000 100,000 34%
100,000 335,000 39%
335,000 10,000,000 34%
10,000,000 15,000,000 35%
15,000,000 18,333,333 38%
18,333,333 .......... 35%

It's rather strange that the rates drop.
 
N

NPOguy

For ease of operation, just have a for-profit branch/division of the
not-for-profit entity. Much like a church run daycare might be taxed
on their profits (if any). If that's not doable, then maybe consider
setting up a for-profit company owned by one or more of the Officers
or Directors of the not-for-profit. More complex I think, as most
NPO's have some turnover in their Board from year to year.
Thanks. One of the reasons that we want to separate the for-profit business
from the nonprofit has to do with liability exposure. The for-profit
business will be very small compared to the nonprofit, and the for-profit
will have very little in the way of assets while the nonprofit does have a
significant amount of assets. Plus, the activities of the for-profit will
be such that the there would be a greater amount of liability risk involved.
So, we are thinking that by keeping the for-profit as a separate entity,
there would be less risk exposure (virtually none) for the nonprofit and the
nonprofit's insurance costs etc. would not go up.

On the other hand, having the officers of the nonprofit own the for-profit
could create some conflict of interest issues -- even though the profits of
the for-profit would only end up going to the nonprofit. I know there are
some ways around that by doing such things as full disclosure and having the
other nonprofit board members vote on the questions involving the for-profit
etc. But, overall, we are thinking that a separate for-profit entity that
is wholly owned by the nonprofit may be the best route.
 
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S

Stuart A. Bronstein

NPOguy said:
paulthomascpa wrote:

Thanks. One of the reasons that we want to separate the
for-profit business from the nonprofit has to do with liability
exposure. The for-profit business will be very small compared
to the nonprofit, and the for-profit will have very little in
the way of assets while the nonprofit does have a significant
amount of assets. Plus, the activities of the for-profit will
be such that the there would be a greater amount of liability
risk involved. So, we are thinking that by keeping the
for-profit as a separate entity, there would be less risk
exposure (virtually none) for the nonprofit and the nonprofit's
insurance costs etc. would not go up.
If liability is an issue, then an LLC or a corporation might be the
way to go. On the other hand doing that will involve additional
cost. Normally (if you have to choose) a good insurance policy is
considered better than the limited liability you get from a
corporation or LLC.

___
Stu
http://DownToEarthLawyer.com
 

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